Profiting from Monetary Policy: Investing Through the Business Cycle

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After that comes recession, and then the whole party starts again.

Keynesian Theory in 5 min

That long, slow recovery has been accompanied by subdued inflation and extraordinary actions from the Federal Reserve and other central banks — massive bond purchases and, in Europe and Japan, negative interest rates. Also, in late , President Trump signed the Tax Cuts and Jobs Act, which provided what looks like a temporary boost to earnings and GDP after eight years of recovery.

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From the Dec. Hofschire thinks this phase is a good time to lighten up on economically cyclical assets and move toward high-quality bonds and defensive sectors such as consumer staples, health care and utilities, which outperform during recessions. Howard R. Gold is a MarketWatch columnist. Follow him on Twitter howardrgold. Economic Calendar Tax Withholding Calculator. Retirement Planner. Sign Up Log In. The changes include a new, responsive design featuring extended-hours data and more news. Learn More. Rating details. Sort order. May 17, Ecoute Sauvage rated it it was amazing.

This is a highly original book that would be more accessible to general readers if its central macroeconomic argument were re-cast into the more mundane terms of corporate accounting and finance. The first step in doing that consists of eliminating all macroeconomic analysis and sticking with the theory of the firm - micro.

That's known to work short, medium, and long term, and its rules have been reasonably well understood at least since the introduction of double-entry book-keeping and more lik This is a highly original book that would be more accessible to general readers if its central macroeconomic argument were re-cast into the more mundane terms of corporate accounting and finance. That's known to work short, medium, and long term, and its rules have been reasonably well understood at least since the introduction of double-entry book-keeping and more likely since deepest antiquity as the term economics itself management of a large estate indicates.

A closer look at sector performance during slowdowns

Second, remember that the original credit theory of Wicksell was subtler than that of his explainers Myrdal-Hayek in the same sense that Keynes's analysis was multi-dimensional, a quality needlessly reduced to the simplistic IS-LM curves of Hicks, which don't allow for economic growth. Third: waves of credit creation and capital destruction are a constant throughout recorded history.

General equilibrium may exist in the same sense paradise may exist as a place where nothing ever happens, but for the most part economic data, static or dynamic, lacks clarity, let alone certainty - and is more reminiscent of Milton's "darkness visible". But the theory of the firm requires us to come up with some solid numbers, and, if calculating values for Wicksell's beautiful waves presupposes finding a general solution for the Navier-Stokes equations, we better find a shortcut because nobody has solved those yet.

Fourth: that shortcut becomes obvious by viewing credit waves as contingent claims: anybody's credit is someone else's debt. The theory of financial distress, aka the solution to the question of when does the debt overhang start to compromise the value of the firm, was first given by Stew Myers of MIT in his classic paper, "Determinants of Corporate Borrowing". Finally, the calculation of the Wicksell differetial can be made with greater precision by calculating via a proxy usually lost as "noise" in standard time series for interest rates and cost of capital composites.

The calculation is given in, inter alia, "Noise as Information for Illiquidity" by Hu, Pan et al, and will not be repeated here. The question "are we making any money in here?


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There are no discussion topics on this book yet. Goodreads is hiring! If you like books and love to build cool products, we may be looking for you. As a result, an investment trigger can be set up based on the dynamic relationship between leverage ratios and the rate of profit, which requires constant recalibration as new data is made available.

Borrow, borrow, borrow… Default Chart 2 shows three leverage ratios — consumer, corporate and government against the Wicksellian Differential highlighting the key drivers of rising and falling profits. The relationship between each leverage ratio and the rate of profit is unique and dynamic through time. For example, the slowdown and fall in the consumer leverage ratio caused the Wicksellian Differential to reverse between and Furthermore, during the tech bubble between and , corporate leverage fell followed by consumer leverage, causing the rate of profit to fall.


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This highlights that there was no real basis for rising equity returns during the tech bubble as the rate of profit growth was falling. The extent of the credit bubble leading up to the recent financial crisis is highlighted by the substantial rise in consumer leverage, the rate of which began falling at the end of , highlighting the downturn in the rate of profit growth in , and thus a shift to bonds.

Finally consumer leverage rose again in , signalling a recovery in profits, although the recovery was short-lived.

Investing Through the Business Cycle

In the trend fell again, and the signal highlights a continuing slowdown in the underlying trend of profit growth. Chart 2: US leverage ratios vs Wicksellian Differential. There are of course other factors that impact profits, such as significant changes in the general price level and in output per worker, as well as other known variables such as the tax rate; however, the most important driver with respect to the turning points is the realisation that a period of credit expansion has become unsustainable, leading to changing expectations.

Conclusion Current attempts by regulators to prevent another crisis — although well meaning — are unlikely to result in an end to the business cycle.

Thomas Aubrey - Credit Capital Advisory

Innovation will continue to drive new opportunities to generate profits, and the subsequent demand for credit to increase investment will be met by the constant innovation of the financial services sector. Investors therefore need to protect themselves from future volatility, given the timing of the next boom and bust is unknown. The cheapest and simplest way of doing this is to switch between equities and bonds triggered by changes in the underlying profit trend. In his excellent FT blog Willem Buiter, now Chief Economist at Citigroup, wrote that since the s most developments in economic theory which underpins much of the current understanding of the way an economy functions have been a waste of time, focusing on the internal logic of problems rather than a desire to understand how an economy works.

Three ways you know you’re late in the economic cycle

As a result investors using the neo-classical framework have too often been on the receiving end of large and unexpected losses. Nothing in this commentary is a recommendation to buy, sell or hold any security. Your email address will not be published. Chart 1: US real GDP growth, real equity returns and Wicksellian Differential The calculation of the Wicksellian Differential is however an ex-post measure, so is unhelpful for investors to use as an investment trigger, hence an ex-ante model needs to be constructed based on the underlying drivers of growth in the Wicksellian Differential, which is of course leverage.

Chart 2: US leverage ratios vs Wicksellian Differential There are of course other factors that impact profits, such as significant changes in the general price level and in output per worker, as well as other known variables such as the tax rate; however, the most important driver with respect to the turning points is the realisation that a period of credit expansion has become unsustainable, leading to changing expectations.

Submit a Comment Cancel reply Your email address will not be published. Highlights Cuneiform inscriptions, interest rates and excess returns What investors can learn from freak waves US Bond Market Trumps Fake News Investors need to ditch equilibrium theory before the next crash Credit cycle shift raises concerns over future consumption.

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